What is Blockchain, anyway?
My cousin in 12th grade recently asked me, “What is a Bitcoin?”. I told her to Google it for herself. She came back after an hour, “I couldn’t understand a thing”.
Wikipedia defines a Bitcoin as “Bitcoin (₿) is a cryptocurrency, a form of electronic cash. It is a decentralized digital currency without a central bank or single administrator that can be sent from user to user on the peer-to-peer bitcoin network without the need for intermediaries. Transactions are verified by network nodes through cryptography and recorded in a public distributed ledger called a blockchain.”
If you go further to investigate the blockchain definition, Wiki says “A blockchain, originally block chain, is a growing list of records, called blocks, which are linked using cryptography. Each block contains a cryptographic hash of the previous block, a timestamp, and transaction data.”
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Now that’s not very straightforward for the non-tech folks around to understand. So, I thought let’s attempt to put it in simplest terms possible, making it fathomable even for the high school kids.
To understand what a bitcoin is, we first need to understand Blockchain, the underlying technology which drives bitcoin.
Trust & Intermediaries
Let’s start with an “over simplified” analogy. Say you are out there looking to buy a used car. Hundreds of used cars are available in the market. After deciding the manufacturer, model, build, and pricing, you are still left with 10 similar cars. Thing that matter now the most is ‘TRUST’. How? Let me explain.
Which one of these 10 cars owners you trust the most. But trust for what? Trust for not hiding any accidental history of the car with you, trust for not sharing any forged documents with you, trust for sharing the complete and correct repair and maintenance history of the car with you, and most importantly, trust for not misquoting the purchase price and market price for the car and the accessories installed.
To bridge this trust gap, we have INTERMEDIARIES. Think of intermediaries as companies which help you with pricing benchmarks, and certify safety and quality standards of the available car options on different parameters (e.g. engine, battery, tyres etc.). The pricing benchmarks and quality certification of these intermediaries help us rank the available options and choose the car best suited to our requirements. Thus they reduce the trust gap we have with each of these sellers. We end up buying the car rated highest by the intermediary in picture. Observe here that, the trust has been transferred. We are now trusting the intermediary while taking the purchase decision instead of the sellers.
This is just one type of intermediary that I described. There are many other intermediaries we deal with till the transaction is completed including but not limited to Banks (for fund transfer), Insurance companies (for insurance ownership transfer) and state’s transport department (for vehicle ownership transfer). Each of these intermediaries have their share of finance charges.
Why do we need these intermediaries? One reason is because we do not have access to the complete and transparent history of the cars. Imagine if you are provided with complete transaction details of the cars you are looking at, as shown in below table, would you still need the intermediaries?
With the availability of above information, it is easy to deduce that the car was first purchased in 2014 for $10,000. Owner David installed a stereo system worth $77. After 2 years, in 2015 the car was sold to Mark at $4,610. Mark spent around 1,000 dollars on the repairs since then.
If this information is available to you for all the cars, you would not need any intermediaries for price validation as now you know the purchase price paid, amount spent on accessories and repairs, and service history of the car. With this information you can infer the condition and market price for the car on your own.
The Blockchain
This is one of core the problems Blockchain as a technology tries to solve. Traditionally record keeping for transaction of any asset in terms of Credit (amount paid) & Debit (amount received) a) is available only to the transacting parties and b) these records do not contain any history of previous transactions of the same assets. What that essentially means is that you as a car buyer would never know the complete transaction history for the car. Also, you would only get to know who the car belongs to and not, who all it belonged to.
Look at the number marking in the last column of Table 1. It lists the block numbers. Every entry in the table is associated with a block number. A BLOCK (also called a RECORD) is nothing but information pertaining to a group of transactions along with reference id of current and the previous block. So the block number 8 contains details of transaction done on Dec 22, 2018 and a linkage to block number 7, block number 7 contains details of transaction done on Aug 01, 2017 and a linkage to block number 6, and so on. This linked chain of “blocks” is referred to as a Blockchain. Speaking in accounting terms, the groups all credit and debit records is called a LEDGER. So a blockchain is nothing but an electronically stored and updated ledger.
Any asset, physical (e.g. car, house) or virtual (e.g. stocks, bonds), can be traded using blockchain as the underlying technology. Bitcoin is just one such asset.
Storage
Understandably, the next question is where are these blocks stored and how can you access the complete transaction history. Blockchain is an internet-based technology. The blocks of validated transactions are stored on multiple powerful computers (called NODES) at different geographies across the globe. Anyone can install the bitcoin software (available free online) and choose to join in as a Node.
These participating computers/nodes are interconnected to form the bitcoin network. Not all nodes are connected to each other but every node on the network is connected to at least one more node. Each node passes on the information of the latest blocks to the nearest nodes it is connected to. This ensures that every node on the network has same and complete information i.e. every full node has all the transaction done on the blockchain since the beginning of the network. The relay of information happens almost real-time over the internet.
This way of storing the information over multiple devices is called DISTRIBUTION. It has certain advantages over traditional ways of storage:
- Primarily, distribution reduces the dependency on any central storage as multiple copies of the chain are stored over the network spread across different nodes. This implies that even if any one node is corrupted or hacked or removed from the network, the network as a whole is not affected ensuring there is no single point of failure.
- This also means that if anyone attempts to alter/edit any completed transaction, they can do it only for one or a few nodes in the network. To manipulate any block on the entire network requires enormous computing power, making it practically impossible to override any blockchain transaction. This particular property of the blockchain technology is called IMMUTABILITY. Immutable simply means unchangeable.
- Distributed ledgers eliminates the need for intermediaries as now you need not depend on the intermediaries you trust to validate history of the asset being traded, instead the trust is transferred to the underlying network to prevent and eliminate any inconsistent information.
Security
If all the transactions on the network are accessible to everyone, why would I even join the network? My transactions are confidential and should be available only to me and the other transacting party. This is a very valid concern. Blockchain addresses this using cryptography.
CRYPTOGRAPHY is nothing but a technique to transform/convert any information to an unreadable secure format. What this means is that all the transactions on the network are transformed (also called ENCRYPTION) into a unique meaningless alphanumeric string. This string, called HASH, serves as a fingerprint to trace the transaction. If any transaction details are altered, the unique hash for the transaction changes, thereby making it impossible to trace the transaction using the original hash. This makes it possible to easily call out nodes with faulty transactions, if any. Anyone accessing the blockchain data would only be able to view the transaction details like amount, date, time and not the personal details of the parties involved in the transaction.
Bitcoin
Assuming that we now have the basic understanding of Blockchain as a technology, we can dive in to understand Bitcoin. Like I mentioned earlier, Blockchain can be used for transacting any asset, physical or virtual. Bitcoin is one such asset.
BITCOIN is digital cash. Since it works on blockchain, it is also called cryptocurrency. It is a digital currency and an online payment system which is not controlled/owned by any one. Bitcoins can be used for financial transactions and are available for purchase on CoinExchanges like Coinbase. You can buy bitcoins at these exchanges by paying in other currencies.
Current trading value (26 Feb, 2019) of a Bitcoin is around USD 3,800. Since it is practically not feasible use a Bitcoin directly for any daily purchases due to its high valuation, there are subunits. A milliBitcoin (mBTC) is a thousandth of a Bitcoin and a Satoshi (named after the founder of Bitcoin) is a millionth of a Bitcoin.
The acceptance of Bitcoins for financial transactions is increasing slowly. Microsoft, Shopify, Dell, Zynga, OkCupid are some of the companies accepting Bitcoins for business payments.
Any transactions happening using Bitcoins are hashed as explained above and are bundled in blocks to be added to the Bitcoin blockchain which is updated every few mins (10 mins or so). These updated blocks and transactions can be viewed at Blockchain.com. Blockchain is updated by miners, a process called mining which is out of the scope of current discussion.
Summary
Blockchain is a new, internet based technology which can be used for peer-to-peer exchange of any physical or virtual assets. It is a distributed public ledger that records transactions of the asset being traded as Blocks. Bitcoin is just one such asset, a digital currency. As any asset can be traded using blockchain as an underlying technology, blockchain finds applications in numerous fields including currency markets, real estate, supply chain, contracts and crowdfunding to name a few.
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